Thursday, November 03, 2011

Pakistan, India, MFN: What are the implications?

For once, I am pleased at how India played it: India gave Pakistan MFN status way back, in 1996, without getting into the silliness of reciprocity. A hallmark of professional competence in international trade is the idea of unilateral liberalisation: Even if another country is silly enough to have barriers against us, we should not have trade barriers against them. Removing barriers against India's globalisation is a favour to us, regardless of what it does to anyone else. India often gets into cul de sacs by obsessing on reciprocity - e.g. we won't open up to imports of agricultural products because the Europeans won't. We won't allow foreign banks to operate in India because some other countries have barriers against the operations of Indian banks. And so on. But for once, in this case, our guys seem to have played it right (and way back in 1996, too!).

At present, there is significant Indo-Pak trade; it merely gets routed through Dubai. Once Pakistan gives India MFN status, the entrepot trade that was going Bombay -> Dubai -> Karachi will go Bombay -> Karachi. This is bad news for Dubai and for individuals and firms which are invested in the future of Dubai as an entrepot centre. Trade data should show a fairly sharp decline in India's exports to UAE and a fairly sharp rise in India's exports to Pakistan.

There will be a boom in shipping, communication and trade serving the direct Bombay -> Karachi route. Similarly, the ports of Gujarat will do a lot of business directly to Karachi.

At first blush, little changes: the goods that used to go via Dubai would now go directly to Karachi. Another dimension is the cost of the middleman in Dubai, which would be eliminated. To a reasonable man, these changes add up to small numbers. But a recurring theme in economics is the extent to which apparently small frictions loom large. The removal of fairly modest frictions matters a lot for business activity. So when the cost of shipping goes down by roughly 3x, even though the cost of shipping may be small in absolute terms, this would have a big impact on trade.

Important dynamics will now set in amidst firms in Pakistan. Firms that compete with exports from India will suffer. Firms that consume imported inputs from India will thrive. Creative destruction will take place; resources will shift from one group of firms to another. Exporters will be better able to export to India, both because of access to cheaper labour and capital that's freed up by firms that die owing to import competition, and because of improved competitiveness that comes from cheaper raw materials. Exports from Pakistan to India will go up significantly through this movement on import liberalisation.

Large Indian and Pakistani corporations will look much more seriously at the opportunities that lie just beyond the national border. Over time, human capacities and human networks will build up on both sides, supporting cross-border operations. This will take time to ripen, but when it does, the effects will be large. A good fraction of global trade is intra-firm trade, so it's very important to have large firms of both countries having operations in both countries, in order to get growth of trade. But for this, both sides have to do more on capital account liberalisation through which firms will expand operations across the border.

The biggest gains in India will be in Gujarat, given the myriad ports in Gujarat which are a short distance away from Pakistan. But in the future, if road and rail links open up, then there are big opportunities in Punjab also. Wouldn't it be nice to have a NHAI style road running from Ahmedabad to Karachi, and from Amritsar to Lahore?

To the extent that we're merely rerouting trade, bypassing Dubai, this will impose no new stress on ports and airports in Pakistan. But to the extent that new trade is created - as I expect it will (and as argued above) - then new work will be required in Pakistan on enhancing the capacity of ports and airports. I would personally be surprised if the effects are not large. In other words, this initiative will need to be followed through by new work on infrastructure in Pakistan.

In the intuition of economists, there is a gravity model in the affairs of men. Proximity and low transactions costs are incredibly important. The natural opportunity for India to grow international integration on all dimensions (goods, services, people, ideas, capital) lies in our immediate neighbourhood. India's connections into the region are shockingly below those seen for all other large countries. Doing better on connections with Pakistan would be a nice step forward.

Consider a product like cement, which is ordinarily considered a non-tradeable. Transportation of cement is so hard, there isn't a unified national market even within India. There are a series of regional markets. But even in this, modifications of transportation have mattered greatly. E.g. when Gujarat Ambuja came up with the innovation (back in the mid 1990s) of sending cement from Saurashtra to Bombay, by sea, this was a very big deal. By that same logic, cement from the coast of Saurashtra can go to Pakistan (or vice versa, depending on who produces at a lower price).

We should not see trade in goods in isolation. All dimensions of globalisation are intimately connected to each other. It is not possible to have mode of internationalisation (trade in goods) without having the others. To do more trade in goods and services, we need more movement of people. Ergo, the silly visa restrictions that both countries impose on each other need to be eased. Finance follows trade: So where trade in goods and services leads the way, bigger financial integration will follow with trade financing, cross-border banking, payments, purchases of information, operations of multinationals and FDI, INR/PKR currency risk management, and investment flows. More will need to be done on investment guarantees, export/import trade financing, etc. Conversely, if all those elements are blockaded, then trade in goods and services will not blossom.

9 comments:

Pakistan is one of the world's largest cement producers- hence it would most likely be exported to India. While I think MFN status is a great move and will surely boost trade, I cant be sure as to how it will pan out in reality considering both controls have tons of bureaucracy that can create unnecessary hurdles.

Thanks for this post giving these details. I was wondering the exact effects of this on Pakistan. We in Pakistan should grab this opportunity and trade with our Indian counterparts as much as possible. Regards visa rules, these being relaxed will also help the national airline who said that if visa rules were relaxed India would be one the biggest destinations for it to fly to. Until these rules are relaxed though the business community can use technology such as skype to interact and contact each other.

The main benefit as i see it is when trade with India is the reason for job creation and uplift of Pakistan. This will give ammunition to counter the India dushman hai league. It will also push forward the peace process as both countries will have a vested interest in peace. We need our economies to be more integrated, this will inevitably lead to peace. Look at how European countries are so integrated, we should be the same. Our future lies in integrating our economy with India's this is a good first step, long may this continue - ameen!

Its sad to see on every website's comment section that 90% of Pakistanis are in favour of peace with India, and 90% of Indians are suspicious of peace.

The writer is right - you have nothing to fear with greater cross-border trade since that trade is just being diverted away from Dubai. Gujuratis may be notorious in Pakistan for being the most rabidly anti-Pakistan/anti-Muslim segment of Indian society, but at least our brothers in East Punjab understand that they stand to benefit from trade with Pakistan! Maybe business-minded Gujuratis will see the benefits that Gujurat would have from closer ties to Pakistan.

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